The Power Of Bankruptcy Judges, A Follow-up

May 4, 2009

Pivoting off a Journal report last week that Chrysler would try to scale back some of its environmental liabilities in bankruptcy court, I asked what other sorts of claims a bankruptcy judge could winnow away. I was particularly interested in tax liabilities.

In response, a number of informed readers--including a clerk for a bankruptcy judge and a bankruptcy law professor--wrote in with some really helpful comments. The gist seems to be that, yes, a company can shed some of its tax liabilities in bankruptcy court (though bankruptcy candidates don't often have huge tax liabilities, as one reader points out, since they don't typically have a lot of profits). This is also true for individuals.

Two other related points. First, a few people wrote in making some version of the following comment: "The judge doesn’t really ‘do’ those things [i.e., wipe out tax or environmental liabilities]: the Bankruptcy Code allows them to be done, the parties make a motion, and the judge grants or denies them." Fair enough--it's worth being precise about this.

Second (and slightly less relevant but also of interest):

One of the only things it [bankruptcy] can't terminate is payroll tax obligations. The employer's legal liability to pass the employees' social security contributions along to the government is a trust relationship, not simply a debt. Even if the corporation is dissolved in bankruptcy, the proprietor or shareholders can be on the hook for that.

This is a big deal, as most bankruptcies are from small businesses and as a small business teeters near the edge it's a common temptation to dip into the payroll tax fund (those funds are withheld every week but paid to the feds every quarter), intending to pay it back just as soon as things turn around.